COGS calculation - small business schedule C

[ptax255]

Hi,

Client buys and sells items on ebay. Should COGS be calculated per an inventory method (average price, specific cost etc), or can he claim all he purchased even though not sold? He says his friend and his accountant just claim all purchases.

Per schedule C instructions, I believe COGS should account for year end inventory, even though he's a cash small business taxpayer. Thanks!

Exception for small business taxpayers. If you are a small business taxpayer, you can choose not to keep an inventory, but you must still use a method of
accounting for inventory that clearly reflects income. If you choose not to keep
an inventory, you won't be treated as
failing to clearly reflect income if your
method of accounting for inventory
treats inventory as non-incidental material or supplies, or conforms to your financial accounting treatment of inventories

[TaxGuyBill]

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@ptax255 wrote:

method of accounting for inventory

treats inventory as non-incidental material or supplies,

or conforms to your financial accounting treatment of inventories

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Is this their first year?  If not, you need to follow their prior "method of accounting".

If this is their first year, one of the options is to "conforms to your financial accounting treatment", which could be deducting the full cost in the year of purchase (something that was added somewhere around the Tax Cuts and Jobs Act).

[ptax255]

I'm not sure that "conforms to your financial accounting treatment of inventories" means deducting when purchasing. Here's another link I could find on this. I was thinking more of any inventory method they choose and on a cash basis (so if they paid for items that they didn't receive yet, it would be included in inventory)

https://www.justanswer.com/tax/nd448-taxes-read-tax-cuts-jobs-act-2018.html

This is the first year, so I want to make sure I make the right selection.

[TaxGuyBill]

It means how do they treat it for their "book" purposes?

If they deduct the cost when purchased for their "book" purposes, they can deduct it for tax purposes (assuming they don't take a physical count of inventory, which is treating it as inventory).  See Example 2 in §1.471-1. 

The link you provided was discussing the "non-incidental materials and supplies".

[qbteachmt]

When I've worked on this type of task it's been an issue of scale.

They can eBay camper trailers, trucks, ATVs. Each is different enough not to use average costing. Some have significant cost. Anything on hand is tracked as inventory if not sold over the year end, to match revenue to the sale date later.

I helped a business handling secondhand children's clothes and toys. They use average costing when they take inventory, They have a brick and mortar location, so they have a significant count of items on hand over the year end.

I helped a water utility. They have an inventory of system repair parts, some of which will be charged to the customers when something is used (meter, valve, pump). These are all deducted in the year of purchase.

[ptax255]

What about deducting when purchased even though not sold?

[qbteachmt]

"when purchased even though not sold"

$35,000 4-wheeler side-by-side?

$350 pair of vintage shoes?

The goal is to match income to the costs required to generate that income. I teach this and use an example of Teddy Bears in the closet. When we buy inventory, we turned money (an asset) into Stuff (inventory asset). The money we spent on the Teddy Bears are right there, when I open the closet.

[ptax255]

I understand. But do you know if there's an exception for small businesses like Tax Guy Bill suggested above?

[qbteachmt]

There are not exceptions. There are three options (since TCJA).

"(so if they paid for items that they didn't receive yet, it would be included in inventory)"

Not for the "deduct it now" option. Here's a snippet from a nice article with a reference table for that "deduct it now" option:

https://www.eidebailly.com/insights/alerts/2022/12/small-taxpayer-inventory-safe-harbor-methods

"Taxpayers must treat inventory consistently in all accounting records. To currently deduct inventory, taxpayers must stop tracking inventory on all accounting records.

For example, a taxpayer wanting to deduct the cost of inventory when purchased would need to stop tracking the inventory on their books and records and could not reflect inventory on their balance sheet, general ledger, trial balance, tax return or other accounting report. They could continue to maintain an inventory system that tracked quantities of items on hand for re-ordering purposes but could not reflect an inventory asset on their financial records for any purpose."

[ptax255]

Thank you for the article. In my case, client has an excel sheet listing the items sold and a separate tab the items bought. Not sure if this is considered "tracking" inventory, but sounds like he may qualify to deduct when purchased.

[sjrcpa]

Sounds like tracking to me.

And you never said what is being bought and sold and approximate cost/sale price. we're trying to get a feel for the materiality.